INTM489795 - Diverted Profits Tax: application of Diverted Profits Tax: examples and particular situations: tangible assets

INTM489783 includes a simple example of plant and machinery held by a group company in a zero-tax territory, when it was acquired for use in the UK by a UK group company.

That example illustrates that in such circumstances it may be reasonable to assume that the involvement of the company owning the asset in the zero-tax territory was designed to secure the tax reduction. It may also be reasonable to assume that in the absence of the effective tax mismatch outcome the provision involving Company C would not have been made.

If the just and reasonable assumption as to the alternative provision that would otherwise have been made or imposed is that the UK company, or perhaps another UK resident group company, would have owned and managed the asset, taxable diverted profits would be calculated on the basis of the additional profits for the accounting period that would follow from that assumption.

However, any such assumption must be based on the detail of the particular facts and circumstances of the material provision. Arrangements through which assets used by a UK company are held in another group company and which give rise to an effective tax mismatch outcome will only result in a diverted profits charge if:

• The insufficient economic substance condition is met; and either
• the transfer pricing of the material provision is not in accordance with Part 4 TIOPA 2010 and that is not corrected before or during the review period; or
• it is reasonable to assume that the material provision would not have been made or imposed in the absence of the effective tax mismatch outcome, and the alternatively structured provision that would have been made or imposed would have given rise to additional profits taxable in the UK.

Close attention needs to be given to all the benefits of such arrangements, which may be linked to the nature of the asset and the way it is used in the group. It is also important to consider where the functions, particularly decision-making functions, related to the design, acquisition, maintenance and exploitation of the asset are carried out. It may also be appropriate to take into account the group’s arrangements in relation to other assets of the same type or class, including where the capacity to perform the functions mentioned above are located.

In many cases it may be possible for businesses to establish that the financial benefit referable to the transaction and the financial benefit from the contribution of functions/activities of the asset owner’s staff is greater than the financial benefit of the tax reduction. If not, the insufficient economic substance condition would still only be met if it is reasonable to assume the transaction(s) or the involvement of a party to the transaction(s) is designed to secure the tax reduction.

However, if the arrangements are within the insufficient economic substance condition then the rules for determining any charge in a section 80 case depend on whether the material provision would have been structured in the same way had tax on income not been a relevant consideration. The considerations mentioned above, (that is, all the benefits of the arrangements, the location where functions in relation to the assets are performed, etc.), will again be key to this question as will the substance of the parties to the provision.

If the material provision would anyway have been structured in the same way, or in a different way that would still have resulted in allowable expenses of the same type and for the same purpose (other than where they would have resulted in additional UK profits), then taxable diverted profits would be limited to any additional profits not included in a return before the end of the review period that relate to the correct application of the transfer pricing rules.

If the material provision would have been structured in a different way that would have given rise to additional UK profits, then taxable diverted profits would be calculated by reference to that alternative provision in accordance with section 85. This could follow, for example, from the tax-motivated separation of the ownership of assets from their use in the UK as well as from the functions related to their design, acquisition, maintenance and exploitation in the UK.